Crosscurrents Aplenty - 07/28/10

But the economic past looks better than the economic future.

In the main, second-quarter earnings (a rearview-mirror indicator) are beating consensus estimates (Twit Olympics?), as the manufacturing profit recovery has outpaced the economic recovery.

More forward-looking economic measures, however, are pointing to an extension of the current soft patch and a moderating domestic economic expansion -- but no double-dip.

 

• The Dallas Fed Manufacturing activity was reported at -21 in July vs. -4 in the prior month and compared to consensus estimates of -2.5. The trend in new orders was undisputedly poor at -9.6 vs. -8.3 in prior month and +15.8 in May.

   

• The Richmond Fed Manufacturing Index also came in weak at 16 vs. 23 in the prior month and compared to consensus estimates of 12. Again, the trend in new orders continued to deteriorate at 24 vs. 38 in the prior month and 50 in May, as did wage growth.

   

• The Chicago Fed National Activity dropped dramatically to -0.63.

   

• Last week's same-store sales, reported by the International Council of Shopping Centers, increased by 0.6%, down from the prior week's 1.4% gain.

   

• New-home sales came in at 330,000, about 20,000 better than expectations, but the previous month was revised downward by 32,000. Moreover, this series fails to account for home contract cancelations, which now account for approximately 20% of all contracts at the major, publicly held homebuilders.

   

• Consumer confidence eroded and was reported at 50.4 vs. a prior reading of 52.9 and compared to consensus of 51. The current assessment was unchanged, but future expectations for the economy tumbled. The employment component weakened after four consecutive months of improvement.

Real GDP expectations for the second half of 2010 and the first half of 2011 are coming down at the economic forecasting shops I respect -- including ISI ("Global Soft Patch") and JP Morgan ("A Bend in the River") -- as the ambiguity of second-half growth continues to point to a cap in the upside to stocks in the months ahead as P/E multiples remain pressured.

Unless transformative policy focused on improving the jobs outlook is shortly implemented by the administration (unlikely), the brunt of decelerating economic growth will be felt by a continued subpar employment picture.

Market bulls argue that the economy is in fine shape and that weak consumer confidence belies strength in the manufacturing sector. Market bears argue that elevated unemployment will ultimately reduce corporate profitability and expectations.

I argue that as stocks move toward the top end of my anticipated second-half trading range (the S&P 500 between 1,020 and 1,150), cash should be raised and equity risk profiles should be reduced in light of the above uncertainties on growth and on valuation.

Simply stated, even though I continue to believe that we have seen the lows for the year, I can see a number of economic outcomes, many of which are less than benign. That uncertainty, coupled with the emergence of a number of nontraditional headwinds in early 2011 (higher marginal tax rates, more costly and cumbersome regulation, etc.) suggests that investors should err on the side of conservatism over the balance of 2010